Coach profit rises 26%, but margin falls short

Leather-goods retailer’s board boosts stock-buyback authorization

NEW YORK (MarketWatch) — Coach Inc. said Tuesday second-quarter profit rose a better-than-expected 26%, after more shoppers visiting the upscale handbag designer’s stores opened their wallets wider.

The company
COH, -0.32%
also said it expects to increase sales and profit at least 10% for the rest of the year and plans to repurchase as much as $1.5 billion of shares by June 30, 2013.

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Still, Coach shares fell 1.7% to $52.43 after the retailer’s gross margin missed Wall Street expectations. The company said it sold more at factory outlets, where most products are specifically made for that channel and analysts say typically yield lower gross margin than that at its full-priced stores.

The company, like other retailers, also said inflationary pressures would dampen gross margin in the back half of the fiscal year. Coach said it’s moving some production in China, where labor wages are rising, to countries such as Vietnam and India.

“This suggests factory stores drove [sales] strength which will be discounted by the market,” said Jefferies & Co. analyst Randal Konik. “Furthermore, the company sees rising sourcing costs pressures on the horizon from leather and labor which should negatively impact gross margins in future quarters. We think gross margins will be down for the remainder of the fiscal year and will dampen [per-share profit] upside in coming quarters.”

Net income rose to $303.4 million, or $1 a share, in the three months ended Jan. 1, up from $241 million, or 75 cents, earned in the year-earlier second quarter. Sales rose 19% to $1.26 billion, the New York-based company said.

Analysts, on average, had estimated Coach to earn 97 cents a share on sales of $1.21 billion, according to a FactSet Research survey.

Chief Executive Lew Frankfort introduced products steadily throughout the holiday season, instead of previously “front loading” early in the season, to spur demand and has rolled out digital gift cards and tapped into social media to engage shoppers.

Coach also has lowered the company’s average handbag price by about 10% to bolster demand during the economic downturn. The company‘s also been expanding overseas in both emerging markets such as China as well as in Europe and has increased sales to men in part through the opening of both full-price and factory-outlet locations.

North American comparable-store sales rose 12.6%. In Japan, sales were flat excluding currency translations but climbed 8% because of a stronger yen, while point of sales in China rose at a double-digit rate, the company said. Coach targets sales in China to rise to $500 million by fiscal year 2014,

The U.S. sales gain “is solid proof of brand strength/relevance,” said analyst David Schick of Stifel Nicolaus & Co. in a research note.

Carried along in upscale recovery

Coach also has benefited from a recovery in demand for upscale products as higher-end retailers including Bloomingdale’s parent Macy’s Inc.
M, -0.39%
Nordstrom Inc.
JWN, -0.04%
and Saks Inc.
SKS, -1.24%
have seen their sales outpace those of other industry segment counterparts, analysts said.

The company had 347 retail stores and 129 factory outlets at the end of the quarter in North America. In Japan, Coach had a total to 171 retail locations and in China, 52.

Indirect sales increased 28% to $168 million, helped by demand in shipments into both international wholesale markets and U.S. department stores.

Gross margin remained at 72.4%, however, as “channel mix” offset sourcing cost benefits, the company said. Selling, general and administrative expenses as a percentage of sales narrowed modestly in the last quarter, to 36.5% from 36.6%.

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